With the impact of the epidemic, the differentiation of the global supply chain has accelerated. As a business owner, no doubt that you have the nonsystematic risk of delayed deliveries and delayed payments. In 2022, the Chinese government raised attention to encouraging enterprises to improve operational efficiency through supply chain financing.
In this article, we review supply chain financing and why it has become increasingly important in China. The topics covered are:
- What is supply chain financing?
- Improving Financial Liquidity with Supply Chain Financing
- Reducing Operational Costs in the Supply Chain
- Legal Service Providers in China for Foreign Companies
What is supply chain financing?
Supply chain financing, as an innovative financing option, has developed rapidly in China. It has become an important field for banks, financial information service agencies, and enterprises to expand their service offerings and enhance their competitiveness because of the unreplaceable benefits. Examples include more efficient financing process, lower operation costs, and more reliable cooperations between companies and institutions.
It provides liquidity for companies promptly and helps each company to conduct business smoothly in international trade. The participants include core enterprises (debtors), financial institutions (creditors), upstream suppliers, and downstream buyers of core enterprises. Sometimes, the creditors can also be core enterprises (non-financial institutions) only if it’s a funding provider in the supply chain.
Small-and-medium sized companies benefit greatly from supply chain financing as this helps them solve their financing difficulties, which is crucial for their survival. Supply chain financing also improves the competitiveness of small and medium-sized enterprises in terms of high capital liquidity, which attracts many long-term cooperation. For example, the Shandong Provincial Department of Finance encourages small, medium, and micro enterprises to improve the efficiency of accounts receivable financing, and rewards supply chain financing innovation projects with a maximum of 5 million yuan.
Core enterprises can also act as fund providers for other members in their supply chain members, to improve the overall efficiency.
This is particularly the case when providing funding for small and medium-sized companies, to support with bank credit and long-term accumulated industry expertise and resources. China’s supply chain finance market has benefited from the increase in the volume of accounts receivable and financing markets. Its scale has expanded by 85.3% in four years, from 11.97 trillion in 2015 to 22.18 trillion in 2019.
Looking at industries, supplier financing is most commonly used in automotive (59.29%), retail (45%), and steel (43.57%). Taking the automobile industry as an example, commercial banks were the main institutions providing supply chain financing services ten years ago, but now the main providers of financial services are gradually diversifying, including Sino-foreign joint ventures, auto finance companies, and other banks and non-bank financial institutions.
In addition, the upstream and downstream of the automotive industry are closely connected, and core companies often choose supply chain financing to help repay suppliers quicker and promote the long-term and stable development of supply chain relationships.
Improving Financial Liquidity with Supply Chain Financing
In recent years, most international payments and settlements are not pay-as-you-go but adopt a transaction model that separates money from goods such as payment in advance or goods in advance. One settlement way called prepayment or sales on credit becomes popular as of its liquidity benefits.
According to the statistics of SWIFT (Society for Worldwide Interbank Financial Telecommunications), 80% of international payments and settlements are sales on credit that means after the buyer and the seller sign a goods agreement, the buyer can take the goods without payment, but pays on the specified date according to the agreement or pays in installments. Sales on credit start to stimulate the single order quantity of downstream companies, reduce inventory, and enhance seller competitiveness.
However, with the continuous development of supply chains, in addition to stimulating sales, sales on credit are also widely used by core companies to optimize their own cash flow. In contrast, traditional bank international trade finance focuses on financing products under traditional settlement methods such as telegraphic transfer (T/T), letters of credit (L/C), and bills, and lacks products based on sales on credit, making supply chain SMEs face increasing financing pressure. Supply chain finance compared to traditional finance is better in terms of liquidity.
Let’s take accounts receivable financing as an example, suppliers of core enterprises can transfer their accounts receivable to commercial banks, which can generally be divided into those with recourse and those without recourse. Since the commercial bank has already conducted a complete credit rating on the core enterprise, the commercial bank can provide timely payment for the supplier based on the credit facility of the core enterprise, to alleviate the shortage of funds in the entire supply chain and improve company’s financial liquidity.
Reducing Operational Costs in the Supply Chain
Supply chain financing saves electronic transaction details in the supply chain IT system within enterprises and uses AI technology and cloud computing automation to complete real-time data collection, analysis, and evaluation.
It improves the capital turnover rate of enterprises, reduces operating costs, builds a developed, interactive, and information-sharing platform for banks, core enterprises, and upstream and downstream, and promotes the improvement of supply chain operation methods.
In supply chain finance, the level of information sharing among small and medium-sized suppliers has increased, thereby reducing the workload of banks in related credit review processes such as due diligence. Therefore, each bank will appropriately lower loan interest rates in the process of quoting customers, which will reduce supplier’s financing costs. On the other hand, increased liquidity and continuous production of suppliers have prompted manufacturers to increase orders and revenue.
Core enterprise (manufacturer)
Compared with the traditional financing model, the supply chain operating under the supply chain finance model is stable, and the manufacturer can increase additional benefits, such as: reducing out-of-stock costs, increasing customer loyalty, and increasing market share, etc.
For banks, the qualification review tasks for SME suppliers in supply chain finance are mainly completed by core enterprises, and banks only play the role of review. Therefore, the reduction of review costs and the increase in the number of loans make the overall earnings improve.
Legal Service Providers in China for Foreign Companies
Due to China’s strong financial regulatory system, foreign banks are mainly able to provide supply chain financing services for foreign companies in China. The reason is that foreign banks can complete due diligence for foreign companies more efficiently than Chinese local banks.
We find that in the above ranking list, many service providers implemented 5G and blockchain technology. For example, DBS is helping companies in the Asia-Pacific region access more affordable working capital globally, using its suite of technologies such as APIs, blockchain, and partnerships with Fintech and e-procurement platforms. Its digital solutions have helped companies of all sizes move to paperless transactions, revealing greater efficiencies and cost savings in their supply chains. Bank of America leverages blockchain technology to bring greater efficiency and transparency to previously opaque paper transactions, which in turn gives the bank the confidence to offer a wider range of financing solutions to customers.
Supply chain financing has grown rapidly in China for the past few years and as an innovative financing option. It offers advantages such as efficient financing process, lower operation cost, and has since become a crucially important financing option for international banks. While the automobile and steel sector dominated the landscape, sectors around logistics and consumer goods have begun to catch up on the supply chain finance trend.
Core enterprises can promote the transformation of their internal organizational structure and corporate governance through the development of supply chain financial services, and thus promote the improvement of supply chain management. In addition, companies can look forwards to greatly capitalize on benefits such as improving financial liquidity through sales on credit and using supply chain finance’s real-time data collection methodologies for operational cost reduction.
Lastly, the management of core enterprises should carefully and carefully analyze the risk characteristics of each link in the supply chain, so that the supply chain management and financial management of the enterprise can promote each other and improve the overall operation ability of the enterprise.